European Central Bank urged to intervene as deflation fears mount

The European Central Bank is under mounting pressure to kick-start the stalling eurozone economy and stave off Japan-style deflation.

Official figures showed inflation across the region fell from 0.7 per cent in April to 0.5 per cent in May – a far cry from the target of just below 2 per cent.

The reading fuelled fears of a nasty deflationary spiral of falling prices, lower profits, investment and wages, and higher unemployment.

Worries: Analysts believe ECB president Mario Draghi has little choice but to act to stop Europe suffering the same fate as Japan

Analysts said it gave ECB president Mario Draghi little choice but to act to stop Europe suffering the same fate as Japan - which has been stuck for years in a spiral of deflation and stagnant growth - when central bank officials meet in Frankfurt tomorrow.

Dominic Rossi, global chief investment officer at Fidelity Worldwide Investment, said the fall in inflation ‘underscores the need for the ECB to act’ having ‘consistently underestimated the deflationary forces threatening Europe’.

Matthew Beesley, head of global equities at Henderson Global Investors, said: ‘Having warned us of the spectre of deflation, Draghi and the ECB now need to convince us that they have a credible plan to tackle this challenge.’

A second report from Eurostat showed unemployment fell from 11.8 per cent in March to a still painfully high 11.7 per cent in April. Figures last month showed output in the region grew by just 0.2 per cent in the first quarter of the year.

Howard Archer, chief European economist at IHS Global Insight, said: ‘The ECB hardly needs any more reason to deliver on Thursday to counter the risk of prolonged very low inflation turning into deflation.’

The ECB is expected to lower its main interest rate from 0.25 per cent to 0.1 per cent or 0.15 per cent and could also cut its deposit rate, which stands at zero, into negative territory.

That would mean banks are charged for holding cash at the central bank – which could persuade them to lend more to struggling households and businesses.

Draghi could also outline plans to offer cheap funds to small businesses through an initiative similar to the UK’s Funding for Lending Scheme.